Australia's banks are exploiting their most loyal customers and the Turnbull government's $6.2 billion bank levy will end in higher fees for consumers, according to the findings of a landmark Productivity Commission inquiry.

The highly-critical 600 page report to be released Wednesday will bring the behaviour of major financial services firms back into the spotlight just one week before the royal commission into the sector begins on Monday.

In March, banks responded to orders from the Australian Prudential Regulation Authority to curb interest-only mortgages by raising interest rates - not just for new loans - but for all existing investor loans.

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The commission found interest on investor loans is tax deductible, meaning a wave of investors is likely to come forward claiming the extra interest on tax, costing taxpayers up to $500 million a year.

"It is completely unsurprising that faced with the opportunity to re-price their loan book as a consequence of a regulatory changes, banks did just that."

In a further criticism, the commission found the market domination of the big four meant customers were likely to cover the bill for the Turnbull government's $6.2 billion bank levy, announced in last year's federal budget.

"It is unwise for the Australian government to attempt to impose additional costs on Australia’s big four banks that benefit from being considered too big to fail," commissioners Peter Harris, Julie Abramson and Stephen King found.

Australia's major banks are about to face a royal commission. Credit:Jesse Marlow

The commission argued the long-standing faith in the "four pillars" of banking stability was an "ad hoc policy that, at best, is now redundant."

The policy meant the banks - the Commonwealth Bank, ANZ, Westpac and the National Australia Bank - have been prevented from being able to take each other over, neutralising their competitive threat.

"As a result, the major banks have the ability to pass on cost increases and set prices that maintain high levels of profitability — without losing market share."

In return for their loyalty, customers have been "ripe for exploitation", with one in two people still banking with their first bank.

Only one in three have considered switching banks in the past two years, accepting interest rates on home loans up to 0.4 per cent higher than new customers.

They are also being gouged by a repackaging of existing financial services products with only marginal differences between them. The commission found 20 of 22 pet insurance products were underwritten by the same insurer.

"Serious problems exist with the quality and the reliability of information in the finance sector," the commission found, highlighting the failure of mortgage brokers to provide accurate information, price competition or product differentiation - despite gaining healthy commissions.

"Overwhelming evidence demonstrates that few consumers either read or understand terms and conditions for products purchased, and it would not be hard to conclude that a segment of the financial system is motivated to keep it that way."

The commission said there had been periods of heightened competition in the Australian financial system, driven by new entrants such as ING, "but this revolution is over," and consumers were paying the price on loans, insurance and credit cards.

"The early 2000s was the last time Australia’s financial system saw a period of fierce competition. If we are to see its like again, we will need a series of policy shifts," said Mr Harris, the chair of the Productivity Commission.

The report was critical of government regulators for failing to properly police the sector and recommended that the Australian Consumer and Competition Commission or Australian Securities and Investment Commission be given increased powers and turned into a "competition champion".

"In a system where all are somewhat responsible, it is inevitable that [at important times] none are."

Mr Morrison ordered the report last year after the Murray Inquiry recommended the government focus on competition in the financial system.